Tracking your crypto taxes can be tricky, especially when dealing with cost-basis calculations. The IRS requires crypto investors to report their gains and losses accurately, but figuring out the right numbers can feel overwhelming. If you don’t calculate your cost basis correctly, you could end up paying more taxes than necessary or facing penalties for incorrect reporting. That’s why understanding how to determine the cost basis of your crypto assets is essential. It helps you stay compliant while ensuring you only pay what you truly owe.
This guide will break down everything you need to know about IRS-approved cost-basis methods. We’ll explain how cost basis works, why it matters, and how different strategies can impact your tax bill. By the end of this blog, you’ll have a clear understanding of how to track your crypto transactions properly. Whether you’re an active trader or a long-term holder, knowing the right way to calculate your cost basis will save you time and money.
What Is A Cost Basis Method?
While filing your crypto taxes in the USA, the IRS requires you to calculate and report your capital gains accurately. For that, you need to have the cost basis of each cryptocurrency handy. But what is a cost basis?
When you buy cryptocurrency, the total amount you pay, including transaction fees, is called your cost basis. It represents the original value of your asset and plays a key role in calculating your taxable gains or losses when you sell or trade. The IRS uses this value to determine how much tax you owe on crypto transactions.
Keeping track of your cost basis is essential, especially if you frequently buy and sell crypto. Without accurate records, you could misreport gains or losses, leading to higher tax payments or penalties during an audit. Proper record-keeping ensures you only pay what you owe.
Approved Cost Basis Methods By IRS
Tracking your crypto transactions for tax purposes is essential, and the IRS allows different cost-basis methods to calculate your gains or losses. These methods determine how much profit or loss you report when you sell, trade, or use cryptocurrency. Choosing the right method can impact your tax liability. Here are the approved cost-basis methods:
Specific Identification (Spec ID)
Spec ID allows you to select which crypto asset you want to sell as long as you have accurate records of each transaction. This method gives you more control over your capital gains.
For example, if you bought 2 Bitcoin (BTC) in 2024—1 BTC for $5,000 in January and another for $10,000 in March—you can choose which one to sell when you cash out. If you sell 1 BTC for $15,000 in December and select the January purchase, your gain is $10,000. If you choose the March purchase, your gain is only $5,000. This method helps you manage your tax burden effectively.
First In, First Out (FIFO)
FIFO assumes that the first crypto you buy is the first one you sell. This method is simple and often results in higher capital gains if your older purchases were at a lower price.
Suppose you bought 2 Ethereum (ETH) in 2024—1 ETH for $1,500 in January and another for $2,000 in June. If you sell 1 ETH for $3,000 in December, FIFO will consider the January purchase first. Your gain would be $1,500 ($3,000 – $1,500). Since older purchases are often cheaper, this method may lead to higher taxable gains.
Last In, First Out (LIFO)
LIFO assumes that the most recent crypto purchase is the first one sold. This method can be useful when prices are rising, as it allows you to sell higher-cost assets first, potentially reducing your tax liability.
For example, if you bought 1 Litecoin (LTC) for $3,000 in March and another for $4,000 in September, and then sold 1 LTC for $6,000 in December, LIFO applies the September purchase first. Your capital gain would be $2,000 ($6,000 – $4,000). This approach may help lower your taxable gains if recent purchases were made at higher prices.
Highest In, First Out (HIFO)
HIFO allows you to sell the highest-cost asset first. This method is popular among investors looking to minimise taxable gains by reducing their capital gains.
For instance, if you bought 3 Cardano (ADA) in 2024 at different prices—1 ADA for $1.50, another for $2.00, and the third for $2.50—and then sold 1 ADA for $4.00, HIFO selects the $2.50 purchase. Your capital gain would be $1.50 ($4.00 – $2.50). Since HIFO prioritises selling the highest-cost asset first, it can help reduce your overall tax burden.
New IRS Rule On Cost Basis Calculation
The IRS has introduced new regulations that change how you report and track digital asset transactions. Previously, you could manage all assets under a single approach, treating them as if they were held in one wallet.
That method is no longer allowed. Now, you must track the cost basis of digital assets separately for each address or broker where they are held.
Impact on Multiple Wallets
Many investors use multiple addresses for security and organisation. However, the new rules require tracking transactions and cost basis for each address individually. This makes tax reporting more complex, requiring updated software or new tracking methods.
Adjusting to the New Rules
The IRS allows you to reallocate the cost basis for existing assets as of 1st January 2025. You must now document asset movements carefully. Reviewing your tracking methods and upgrading your digital asset tax software will be essential for compliance.
Conclusion
Understanding your cost basis isn’t just about following IRS rules—it’s about taking control of your crypto taxes. The right method can help you optimise your tax bill, avoid costly mistakes, and stay stress-free when tax season arrives. Whether you’re an active trader flipping tokens daily or a long-term holder sitting on your investments, choosing the right cost-basis method makes a big difference.